America's Trade Deficit Is Largely Paid For By European Investment In American Manufacturing

There's almost no economic subject that causes more confusion and expressions of ignorance than the trade deficit. Every time any of us writes about it we get deluged with comments insisting that the deficit makes us all poorer, that it reduces the number of jobs in America, that we only pay for it by borrowing, even that the deficit causes the government to borrow from China. Absolutely none of that is true in the slightest and here's the reason why. The US trade deficit is largely paid for by Europeans investing in American manufacturing. Yes, I know, sounds odd but it is in fact true.

The basic point that has to be understood is that the balance of payments does, by definition, balance. The balance of payments (leaving out some minor stuff) is the capital account and the current account. The capital account is, well, capital - what Americans are borrowing from abroad, what capital items like companies, property and so on Americans are selling to foreigners. This is also, obviously, the same as however much it is that foreigners are investing in the United States.

The current account is the actual trade stuff. And yes, the US buys rather more in goods made by foreigners than foreigners buy of goods made in America. That's the trade deficit that we normally see being reported. Although that's not quite right, that's the trade deficit in goods. We then need to look at services and foreigners buy rather more services produced by Americans than Americans buy of services produced by Johnny Foreigner. The world watches Hollywood movies while French movies get a three day art house run on 2.5 screens sort of thing. The US runs a substantial trade surplus on services. The combination of these two (again, keeping things simple and ignoring minor details) gives us the overall trade deficit. And this will be offset, exactly, by a capital surplus because that balance of payments thing does really balance.

At which point we'd like to know how that capital account is made up. Are we borrowing all that money? Selling off chunks of America to finance Chinese tchotchke? As it turns out, no, not really:

U.S. exports are weak, thanks to sluggish demand in Europe, commodity-producing countries and even China, which is facing slowing growth as it seeks to rebalance its economy. Meanwhile, opposition leaders around the world are questioning everything from immigration policies to the status of the U.K. in the European Union.

But for the U.S., at least, there’s a major bright spot: The country saw a record $348 billion in foreign direct investment last year, mostly from Europe, and could attract a similar amount this year.

Foreign direct investment is the type of foreign investment that doesn't just go into bonds or stocks (that's portfolio investment) but which goes into building real economic assets. The report itself has more details:

The United States is the largest recipient of global FDI with an inward FDI stock of $2.9 trillion on a historical-cost basis in 2014. On a current-cost basis, the United States’ FDI stock was more than three times larger than that of the next largest destination country in 2014.2 Investment in the United States remains strong; total stock of FDI in the United States grew at an average annualized rate of 6 percent per year from 2009-2014. FDI inflows in 2015 alone totaled a record $348 billion, rebounding from 2014 ($172 billion), and well above 2013 inflows ($201 billion).

The U.S. manufacturing sector continues to draw a considerable share of FDI inflows11 . From 2010-2012, manufacturing’s share of FDI inflows averaged 44.9 percent, and has increased to 66.4 percent during the 2013-2015 period. Outside manufacturing, sectors that received significant FDI inflows from 2013- 2015 were wholesale trade (11.3 percent of total FDI), finance (except banking) and insurance (10.0 percent), and information (8.3 percent).

Worth just checking against the trade deficit number here. In 2015 the goods trade deficit was $700 billion and change, services surplus near $300 billion for a net trade deficit of $500 billion odd. That's the $500 billion that needs to be financed by the surplus on the capital account. Near two thirds of that came from FDI, largely European, and the majority of that FDI is going into US manufacturing.

So, not entirely and wholly accurate but a reasonable enough statement. The US trade deficit is being financed by largely European investment into the US manufacturing sector. Not therefore something we need to worry about, is it? And also not what we're generally told either. But them are the facts, them really are.